Trading Earnings Optimism With Options in Red Hat Inc

Red Hat Inc (NYSE:RHT) : Trading Earnings Optimism With Options

Date Published:
2017-08-16

PREFACEThere is a powerful pattern of optimism and momentum in Red Hat Inc (NYSE:RHT) stock right before of earnings, and we can capture that pattern by looking at returns in the option market.
The strategy won't work forever, and in fact, it hasn't even won more often than it has lost, but since this strategy has a celever risk control, the winning trades are so much larger than the losing trades, that it has returned 201% annualized returns.

PREMISE
The premise is simple -- one of the least recognized but most important phenomena surrounding this bull market is the amount of optimism, or upward momentum, that sets in the two-weeks before an earnings announcement.
Now we can see it in Red Hat Inc.

The Options Optimism Trade Before Earnings in Red Hat Inc
Let's look at the results of buying a monthly call option in Red Hat Inc two-weeks before earnings (using calendar days) and selling the call before the earnings announcement.

Here's the set-up in great clarity; again, note that the trade closes before earnings, so this trade does not make a bet on the earnings result.

Now, unlike many of our other set-ups, this is in fact a straight down the middle bullish bet -- this absolutely takes on directional stock risk, so let's be conscious of that before we see the results, because they are mind bending.

Here are the results over the last three-years in Red Hat Inc:

RHT: Long Call

% Wins:

42%

Wins:
5

Losses:
7

% Return:

92.7%

% Annualized:

201%

We see a 92.7% return, testing this over the last 12 earnings dates in Red Hat Inc. That's a total of just 168 days (14 days for each earnings date, over 12 earnings dates). That's an annualized rate of 201%. That's the power of following the trend of optimism into earnings -- and never even worrying about the actual earnings result.

We can also see that this strategy hasn't been a winner all the time, rather it has won 5 times and lost 7 times, for a 42% win-rate and again, that 92.7% return in less than six-full months of trading.

Setting Expectations
While this strategy had an overall return of 92.7%, the trade details keep us in bounds with expectations:
➡ The average percent return per trade was 11.96%.

WHAT HAPPENED
The personality of this bull market is one that shows optimism before earnings -- irrespective of the actual earnings result. That has been a tradable phenomenon in Red Hat Inc.

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